Quantitative Easing and Exuberance in Government Bond Markets: Evidence from the ECB's Expanded Asset Purchase Program

Abstract

SUMMARY -This paper examines whether the ECB's Quantitative Easing (QE) policy is causing government bond prices to deviate from their fundamental value.We use a recent advance in the methodology to measure exuberant price behavior in financial time series introduced by Phillips et al. (2015). We extend this methodology and apply it to government bond prices. The results show that the QE policy substantially inflated government bond prices in Euro Area countries to such an extent that bond prices are no longer in line with the underlying fundamental value. We argue that careful monitoring is required when the QE policy is eventually reversed. The test procedure outlined in this paper provides a monitoring tool to do so.JEL-code -G12; G15; E52

The ECB's asset purchase programme: Theory, effects, and risks

“…The bank-centric structure of the EA's financial markets apparently weakens the significance of this risk. Moreover, empirical evidence shows that equity valuations were in line with historical standards in the first stage of the UMP and that the data did not signal exuberant price dynamics for government bonds also in the years preceding the economic stagnation of 2018-2019 (see Blot et al, 2017;Cecchetti & Taboga, 2017;Droes et al, 2017;ECB, 2018). Hence, the risk of asset price bubbles was not a major concern in the EA at the peak of the recovery after the international crisis.…”